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Proposed 2017 changes to private corporation taxation

As it promised in the 2017 Federal Budget, the government is considering changes to the taxation of private corporations. A consultation paper was issued on July 18, 2017, with a comment period open to October 2, 2017. The consultation is not looking at tax on active business income. Rather, it focuses on what the government calls “unfair tax advantages”, as detailed further below. You might think that would mean outright tax evasion and other clearly illegal activities, but much of the scrutiny is on planning techniques that are well within the boundaries of current law and have been used transparently for years, and even decades.

Sprinkling income

It has been a longstanding practice to involve family – lower bracket or otherwise – as shareholders of private corporations. Reduced taxes can result by sprinkling dividends and capital gains distributions among those shareholders, who further may be able to claim the lifetime capital gains exemption (LCGE) on disposing of certain shares. The current LCGE is $835,714. In 1999, the government introduced the tax on split income (TOSI). Perhaps better known to many as the “kiddie tax”, it effectively imposes top tax bracket treatment. Those rules focused on minor age children, but the current proposals go much further:

• Extend TOSI to adult children, particularly if they have little involvement in the business
• Limit LCGE claims by minors and by adult children to whom the new TOSI rules apply

The TOSI changes would apply as of 2018, and LCGE limitations would apply to dispositions after 2017. Business owners should be speaking to their legal and tax advisors now about current dividend practices and whether a restructuring of share ownership might be warranted.

Passive investment portfolios

This is self‐evidently the area that is of most direct concern to professionals who advise business owners on securities investments. Corporate rates on business income are lower than top personal rates. This leaves more money to reinvest in the business, but if the cash isn’t needed there then it can go into a passive investment account. While current rules (mainly refundable dividend tax on hand, or RDTOH) discourage this to some extent, the government wants to assure that “savings held within corporations are taxed in a manner that is equivalent to savings held directly by individuals.”

Two very complicated alternatives (“apportionment” and “elective”, if you’re searching for the terms) are proposed to correct this RDTOH shortcoming. Either way, any deferral advantage will be eliminated. Whatever the final decision on the mechanics, it seems certain that corporate accounting will become more complicated. No specific date is given for when this part of the proposals would apply, though it does state the intention to design new rules “over the coming months.” Input is solicited from those who wish to share their views, with seven questions set forth for comment, including whether this should apply to all private corporations or just corporations using the small business rate, and how transition into a new regime would occur.

Converting regular income into capital gains

Income is normally paid out of a private corporation in the form of salary or dividends to the principals. Until paid out, it is considered undistributed corporate surplus. Here, as in many situations, both salary and dividends are more highly taxed than if a capital gain is realized. Some tax planning manoeuvres purport to convert such surplus into capital gains, commonly referred to as ‘surplus stripping’.

Section 84.1 of the Income Tax Act is an anti‐avoidance rule designed to combat surplus stripping. Generally it applies on sale of shares of a Canadian corporation to another Canadian corporation on a non‐arm’s length basis. Techniques have developed over the years that work around s. 84.1. Along with the consultation paper, draft amendments to s. 84.1 were released that directly target these planning techniques. The amendments are to be effective as of the release date, July 18, 2017.

Effective dates

These are very significant tax changes facing business owners, both within their corporations and in their ownership of them, so it bears repeating the timelines:

Dividend sprinkling, TOSI & LCGE

• Generally 2017 year‐end
Passive investment portfolios
• Consultation in coming months
Converting income to capital gains
• July 18, 2017

Coming into the end of 2017, expect that tax advisors will be busy discussing options and taking action with business owners. Depending on the situation that may lead to a need for a cash infusion into the business, or potentially a cash release by dividend from corporation to shareholder. With respect to passive investment portfolios specifically, and even in the absence of these changes, business owners will need to be thinking about migrating corporate money into personal hands eventually anyway.

Speak to your Meridian Wealth Professional for perspective on these important issues.

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